The Road To Hell…

When I read articles such as this one, Taxing Financial Transactions: Heading for an Own Goal, I sometimes despair. Both for the policy that is proposed and for how the various interested parties for or against a policy cloud their judgement. I really have to ask, “What are you trying to accomplish?”

To wit:

Taxing financial transactions has long been proposed as a way of putting a brake on volatile financial markets, curbing speculation, and bringing in some revenue. In September last year the European Commission published a draft of a directive that would set the levy at 0.1% on cash and securities transactions and 0.01% on derivatives, reckoning that the annual revenue could be as much as €57 billion ($XX billion).

One of the primary factors of the global financial crisis was that banks and other assorted financial institutions implicitly believed that, at the end of the day, governments would step behind them and bail them out. This was the case with Bear Stearns, when the Fed/Treasury Dept/Government orchestrated its sale to JP Morgan to stave off disaster in March 2008. When faced with the same situation 6 months later with Lehman, Paulson and Geithner elected not to stand behind the firm in a sale transaction, scaring off potential suitors like Barclays and leaving the firm to fend for itself. Lehman couldn’t, declared bankruptcy and, ultimately, pieces of Lehman went to the various suitors.

The tsunami of shitstorm that decision unleashed led to TARP, Goldman and Morgan Stanley converting to traditional bank holding companies, etc. Across the pond, England faced the same situation with RBS, the Irish with their bad banks, etc.

Its clearly evident that the taxpayers would be bailing out these big financial institutions and, since then, policy makers have been trying frantically to figure out to avoid this situation. In the parlance, they were trying to disincentivize financial institutions from taking on these risks and get the taxpayer off the hook of these potential liabilities. Clearly, letting firms fail was not the desired mechanism. One of the suggestions was to levy a financial transaction tax, like the one above that will potentially raise 57 billion euros per year.

The urgency to introduce an FTT is partly inspired by the need for revenue. Now that governments have committed billions to rescuing one euro-zone country, or banking sector, after another, there is an even more acute need for cash.

While this money will surely help repair balance sheet damage caused as a result of the last few years’ worth of bailouts, does it not create a justification for future bailouts? This tax is akin to banks paying an insurance premium and when shit hits the fan, they can now come cap in hand to the government for bailouts. I’m half-convinced this has the potential to incentivize financial institutions to take on increased risk, not less. The hitherto implicit belief that governments would stand ready to bail out TBTF institutions will now become explicit. Does it not, then, accomplish the opposite of “putting a brake on volatile financial markets, curbing speculation?”

Certainly if my bank was about to go under, I would go cap in hand to government and point to all the dough they’ve collected as the honeypot with which to bail me out, especially as the honey was collected for paying for my mistakes.

***

Interestingly, I’ve come to view Canada as a land lost in time, where the rules of economics still apply and the rest of the world has gone bizarro. Not coincidentally, I believe it was the only G8 member to actively lobby against this kind of tax (and maybe Australia).

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12 Responses to The Road To Hell…

  1. zolltan says:

    I’m actually not sure which way I stand on the Tobin tax, but let me try a counterargument. Let’s say that letting big banks fail is a non-option, which is something you’re starting out with as a premise and I generally agree with. In that case bailouts are an inevitability when a bank starts to go under whether the guarantee is more or less explicit. I don’t see the Tobin tax affecting the degree to which bankers will assume bailouts. And besides, it’s not like bankers don’t feel bizarrely entitled as it is. Put less confrontationally, it’s very difficult to come up with a policy that would trick bankers into thinking they won’t be bailed out without actually going through with not bailing them out. And when you make that the explicit goal of your policy, then it’s actually impossible, because bankers can read.

    On the other hand, a transaction tax disincentivizes transactions in a very real way – the same way a tax on cigarettes disincentivizes smoking cigarettes. In other words, the problem of “discouraging risky behaviour” and “ensuring bankers don’t think they’ll be bailed out” are not necessarily the same problem and can be decoupled. The issue here, the one you point out and I agree with, is that, given bank failure, the same bailout rigmarole would have to be gone through, and the transaction tax doesn’t actually at all deal with this issue. I think strict personal penalties for individuals would be an effective deterrent here. “breaking up the banks” so that letting them fail one by one is an option could also alleviate this problem a little, but even then not totally.

    As for Canada’s current government lobbying against increase of taxes the brunt of which would fall mainly on the super-rich, that is such a dog bites man story that you don’t really ever need to bother asking whether there’s economic justification for it, and indeed if there is so, consider it a lucky coincidence.

    • Zuuko says:

      The levy proposed above is a version of the Tobin tax, but its not that tax.

      I think you start off on the right track with your comment, but go off track slightly because the devil is in the details. First, I think its clear that government support is needed to stand behind and stabilize a financial system (its not that bankers feel this is an entitlement; this should be the starting point). But, I think its very important to maintain the distinction between the implicit guarantee and the explicit one. The problem as I see it is that governments did not account for these bail-outs in their budgets pre-crisis and now are trying to generate funds to repair this hole. If the point of the tax is to raise funds to plug this hole, ok then lets all be clear that that is the goal. And this is fine by me.

      However, the part that is the big mistake is pretending that this tax is a good idea because it will serve as a deterrent to reckless behaviour on the part of banks and other assorted financial institutions. Keep in mind that behaviour as it relates to finance is very different than health effects of cigarettes. At the end of the day, people realize that cigarette smoking is bad for you and the governments efforts to artificially raise prices via taxes is a subtle reminder that you should stop doing it. Overtime this will lead to changes in a population, i.e. lower rates of smoking. However, financial transactions in of themselves are not a bad thing. As globalization, trade, etc. continues, we will have more transactions, not less. Levying a tax on it will not stop or slow these transactions. All this tax will do is raise the cost of doing these transactions. And I’m totally fine with this. This increased cost is paid to the government and governments clearly need money. Whereas politicians are burying this tax increase through levying these types of transaction taxes, I think the population will be better served in Europe at least by simply creating a Europe-wide tax, which I have suggested before.

      As I have pointed out elsewhere (I think on the whole environment post), simply levying taxes is only going to fix a very, very, very small part of the problem. As transactions in of themselves are not the problem, its the banking practices that are (i’m including a whole host of things in hear from compensation, bonuses, board duties, concept of shareholder maximization, bank size limits, breaking up commercial banks from investment banks, etc.). More regulation is needed to govern banking and finance practices. We cannot lose sight of this people.

      Also, your comment on Canada’s government is off base. They rightly lobbied against this type of transaction tax, which has nothing to do with rich or poor. Canada’s tax system for earnings is more progressive and the Conservatives I believe did lobby against further taxes to the super-rich in terms of their earnings. But again, the system is more progressive to begin with than say the US. So, I’m thinking you’re in a mixing you’re metaphors-type situation. Again, devil is in the details. And this is a whole different issue

      • zolltan says:

        So I mostly agree with the upshot of this: there will still be future bank catastrophes which the transaction tax does little to curtail, and other steps need to be taken here (I suggested laws that specify penalties to individuals, you suggest banking regulations to tackle a series of problems all of which I agree are the problems.)

        You don’t have to think of a transaction tax in terms of good and bad, though. Hell, even for smoking, I’d rather not think of it in terms of good and bad. What people are doing by smoking is imposing a negative externality on others (who have to inhale their stank ass second-hand smoke and pay for their medical bills), and so they should pay for this. This to me is a much better way of viewing this than “smoking is bad” (this paragraph brought to you by my ongoing crusade against getting morality mixed up in economics). Similarly, financial transactions aren’t good or bad, but they impose a negative externality of potentially royally fucking shit up for people who have nothing to do with them (c.f. financial crisis). Therefore, it seems reasonable to me that this negative externality be priced into them in the form of a transaction tax.

        But the issue I see with a transaction tax at least as I heard it explained, it most penalises the computerised microtrades of the “millisecond arbitrage” type with respect to other kinds. The reason I’m not sure about transaction taxes is that I don’t know to what extent those kinds of trades (which, granted, add little to nothing of value to society, so I’m not particularly bothered to defend them) are actually a big part of the problem, so I don’t know to what extent it reduces “risky trades”. You probably know more about whether this is the case, in which case you should tell me.

        As for the Canadian government being pro lowering taxes on the rich, it’s a question of levels versus trends here. Canadian conservatives are starting from a much more progressive status quo. That doesn’t mean they are much more progressive. That just means they are starting out with what they have, and moving it in a consistently regressive direction. As to whether the brunt of the financial transaction tax falls mainly on the rich, I don’t see why you would dispute this. Both the “investor class” and the employees of finance companies (which are the possible bearers here) are upper-middle-class-to-rich. Again, there may be good reason to oppose this tax, but the fact the Canadian government opposes it tells us nothing except that probably rich people would have to pay it.

  2. zzzanna says:

    I semi-agree with zolltan…maybe some ‘reckless’ bankers would feel safer or more justified doing riskier transactions since this tax is being imposed on them.. But hopefully most ‘reasonable’ bankers will not change their ways just depending on the addition of a transaction tax.
    From point of view of poor-undergrad who can’t even get a job in finance (yet?) I like idea of government getting more revenue from rich institutions than from people paying taxes (if that tax money would be used to ease our taxes, and not just kept on reserve to bail out banks) …does that make sense? :S

  3. zolltan says:

    As an aside, I’m not sure why you (zuuko) are so dismissive of the effects of taxes on discouraging certain activities. All other things being equal, if an activity becomes more expensive to engage in without becoming any better in any other way, it becomes a worse idea to engage in that activity than previously. So, people will engage in this activity less.

    I mean, I get the argument against this: “Despite the ever rising cost of living, have you noticed how it remains so popular?”

    But I think most things are a lot more like “smoking cigarettes” than they are like “living” and my evidence for this is that something as sticky as amount of driving (most people do most of their daily driving to commute, you can’t change the length of your commute quickly or easily) decreases with increasing gasoline cost. Note that this decrease has nothing to do with people thinking that driving is “bad” and gasoline prices reminding them of this fact which is your alternative mechanism for smoking. It’s just that when gasoline becomes more expensive, people prefer using less of it, so they do.

    • Zuuko says:

      Taxes, when used as a disincentive, can only be applied on certain activities. For example, smoking is a perfect example. You want to discourage the habit and so levy the tax. When the tax was levied, did people pretend that this was going to be a long-term stable revenue source? No (thankfully). If they had, they would be making a stupid mistake. If the tax is successful and smoking rates go down, so will your tax revenues. That makes sense right?

      Ok. That was a simple example. Let’s try one more complex. The government of BC introduced carbon taxes in Feb 2008. The idea is to reduce the use of carbons. Ok… how can people simply reduce the use of carbons? Unlike smoking where the product was taxed, now the government is applying this tax on an element which forms part of a lot of products. So, the idea is to minimize the use of carbons? How does one do that (unlike the case of smoking where its obvious how to minimize that tax)? Well some hard ways are to stop using wood products for paper, building houses, etc. as the tax applies on forestry companies. Pretty hard to do that. Some easy ways to reduce paying this tax are to reduce your level of driving. Ok… how does someone not living near a skytrain do that in the Greater Vancouver Regional District? Outside Vancouver, there is no practical forms of public transport, such as buses that run every hour. So, reducing driving is impossible for some people. Even in the easy case of driving, its pretty hard to figure out and then let alone try to modify your behaviour to reduce your carbon consumption.

      But you say, well over time people will take measures that reduce their total carbon consumption. To that, I say fine… we don’t know how long over what period or how people could this but lets buy the notion that its this tax that is causing this reduction. The tax was also sold as revenue-neutral, i.e. the BC government cut personal taxes by the same amount as they would raise by this carbon tax (conveniently, the income tax cuts were across the board, while the carbon tax increase affected some industries or parts of the population more than others; leave it to politicians on how to sell). If the tax is successful and carbon-consumption falls, it stands to reason that revenues from this tax will fall and eventually, the income tax cuts passed earlier would have to be reversed.

      Ok so now lets go to the next level with this financial transaction tax, which is supposed to magically reduce financial risk while plugging government balance sheets. If the tax is successful, then the types of transactions included in this tax will go down is the thinking. Except what that the types of transactions on which you could practically institute this tax is on the simple exchange of financial assets, which in of themselves are not risky. The true risky behaviour (eg. how much of financial assets you have on your balance sheet vs. your equity for example) which should be disincentivized by the government, will not be affected by this tax. On the other hand, if the market figures out a way to structure around the tax (rest assured we’re very good at getting around taxes), then not only will governments not have disincented risky behaviour, but the tax they thought they had to plug the gap will yield diminishing revenues over time.

      This financial tax is no different than any other pigovian tax (the economist’s technical term). Neither does this financial transactions tax escape the limits or criticisms of pigovian taxes in general.

      • zolltan says:

        Okay, but all you are saying here is that Pigovian taxes can’t simultaneously (a) discourage behaviour and (b) provide the same level of revenue as if they did not discourage this behaviour.

        But I don’t see anyone claiming that that’s possible! All anyone claims is that they EITHER discourage the behaviour or provide the tax revenue. Or, like Abe Simpson sez, a little bit from column a (slight decrease in behaviour), a little bit from column b (slight increase in revenue).

        As to your criticism of the Carbon tax, I don’t need to tell you that governments and tax policies change over relatively short periods of time, so if a particular tax’s revenue stream decreases, that isn’t really something a government can’t deal with (except in Washington State, where thanks to Tim Eyman’s referendum, a 2/3 supermajority is necessary to raise any taxes! Har har har). Nor is decreasing carbon use this impossible riddle for most people! Even if one has to drive everywhere, the next car one buys can be one that eats less gas. Obviously it’s harder to reduce carbon use for some than for others. But the whole deal is that carbon use imposes a negative externality on others, so it’s eminently sensible that there could be a scheme where it costs some money to use carbon.

        Say I’m dumping chlorine into the water stream from a paper bleaching operation that I run, And say the government develops a chlorine dumping tax. I could complain that the new chlorine dumping tax is unfair because Betty’s Bakeshop down the street already wasn’t dumping any chlorine into the water stream and so doesn’t have to make any sacrifices to reduce their tax expenses. But I don’t expect too many people to be sympathetic.

        But look, we both agree that Pigovian taxes have their place as long as you don’t come in with unfulfillable expectations. The problem with this particular tax is that you say it doesn’t discourage the particular form of trade we want to discourage. If that is indeed correct, then it’s not a good idea, and that should be the primary argument against it, rather than that it’s a Pigovian tax.

    • Zuuko says:

      On the unfulfilled expectations part, I guess you could characterize it that way. And you’re right in that the problem with the tax is that it doesn’t discourage what it is meant to discourage (its behaviour, not trade by the way). I should clarify though that this doesn’t make the tax a bad idea. We should all be clear that his particular tax will raise revenue for governments, while discourage certain types of transactions and it won’t discourage reckless behaviour of my brethren. If everyone understands that, that’s great. This post isn’t meant to be supporting or not supporting the actual levying of the tax itself.

      Intentions and understanding consequences are important.

    • Zuuko says:

      Also, I find your examples to be self-serving, much like the politcal hacks who support or don’t support this tax.

      • zolltan says:

        In terms of “trade” in my comment, I meant that as “a trade” rather than “the concept of trade”, sorry the wording came out clunky. I think on the financial transactions tax, we’re actually much closer to being on the same page than it first appeared. I guess what I’m interested in learning is this: is there a way to structure a Pigovian tax such that it would specifically discourage super highly leveraged trades and the most risky financial behaviour in general?

        In terms of the carbon tax, I don’t think my examples are “self-serving” – they don’t put me personally in a good light, in fact they have nothing to do with me at all. If you mean that I picked examples that support my point rather than those that oppose it – well then, obviously, but it’d be kind of silly to do the reverse.

        But to be less flippant about it, is there a real problem with my paper bleacher v. bakeshop example? I really do see carbon emissions as a form of pollution, so I think analogising it to another form of pollution is not much of a stretch. If it helps, the initial example I came up with was a puppy killing company, but then didn’t use it ’cause I think that WAS too much of a stretch (because it’s not clear how the general populace benefits from a high prevalence of puppies).

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